Reconsidering the Fraud Exception to the Parol Evidence Rule

by Hinshaw & Culbertson LLP
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The California Supreme Court has removed a legal barrier for litigants seeking to invalidate contracts on the basis of fraud. 

Overruling a 75-year old decision, the Supreme Court ruled that the parol evidence rule does not exclude evidence of allegedly false promises or representations that directly contradict a contract’s written terms. See Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Assoc. (filed Jan. 14, 2013). 

This case did not specifically concern insurance, but the ruling could have ramifications for contract disputes between insurers and insureds. 

Insurance coverage disputes sometimes involve allegations that the insurer or its agents misrepresented policy terms. Insurers have a number of potential defenses to respond to these claims, including the parol evidence rule. As applied prior to Riverisland, the rule excluded evidence of any alleged false promise that directly contradicted the express terms of the insurance policy. See, e.g., Diamond State Ins. Co. v. Marin County Bikes, 2012 U.S. Dist. LEXIS 181329 ** 39-41 (N.D. Cal. Dec. 21. 2012) (dismissing fraud claim because alleged misrepresentations about coverage contradicted policy terms).

The Parol Evidence Rule

The parol evidence rule excludes evidence of any prior agreements or contemporaneous oral agreements that contradict the terms of the written, integrated agreement. See California Code of Civil Procedure § 1856; California Civil Code § 1625

The rule is founded on the principle that the written terms of an integrated contract supersede statements or promises made during negotiations. The doctrine’s purpose is to provide certainty as to what constitutes the final terms of the parties’ agreement. Disputes about the admissibility of “parol evidence” thus should be distinguished from disputes about allegedly ambiguous terms -- the parol evidence rule comes into play when a party is attempting to add a new term to a contract not where there is a disagreement about the meaning of existing terms.

Exceptions to the Parol Evidence Rule

The law recognizes exceptions to the operation of the parol evidence rule. Evidence of prior or contemporaneous statements is admissible to challenge the validity of an agreement itself or to establish fraud. Cal. Code Civ. Proc. § 1856(f),(g). As the Riverisland court explained, a rule “intended to protect the terms of a valid written contract” should not “bar evidence challenging the validity of agreement itself.” 

Under longstanding California Supreme Court precedent, the fraud exception to the parol evidence rule had been narrowly circumscribed. See Bank of America v. Pendergrass, 4 Cal. 2d 258, 263 (1935). The Pendergrass court ruled over 75 years ago that evidence of an allegedly fraudulent promise could not be admitted to prove a promise that directly contradicted the contract’s express written terms. Rather, evidence offered to provide fraud “must tend to establish some independent fact or representation, some fraud in the procurement of the instrument or some breach of confidence concerning its use, and not a promise directly at variance with the promise of the writing.

About Riverisland

Riverisland abandoned this distinction. The plaintiffs in Riverisland had restructured a debt agreement. In the new contract, the plaintiffs pledged eight separate parcels of real property as collateral for the loan. The new contract also specified that the credit association would not take any enforcement action for three months after execution of the contract. The plaintiffs signed the contract and initialed the legal descriptions without reading the contract.

The plaintiffs did not make required payments, and a year later the credit association recorded a notice of default. The plaintiffs then filed an action seeking damages for fraud and negligent misrepresentation. They alleged that the credit association’s vice president met with them two weeks before the contract was signed and told them that the association would extend the loan for two years in exchange for additional collateral consisting of two ranches. These alleged promises directly contradicted the written contract, which provided for a forbearance of only three months (not two years) and listed eight parcels as collateral (not two).

Citing Pendergrass, the trial court granted summary judgment for the defendant on the basis of the parol evidence rule. The court held that the fraud exception to the parol evidence rule did not apply because the credit association’s alleged oral promises directly contradicted the contract’s express terms. The Court of Appeal reversed, reasoning that Pendergrass applied only to promissory fraud and that false statements about the content of the agreement were factual misrepresentations and not false promises. 

Overruling Pendergrass

The California Supreme Court reconsidered Pendergrass and expressly overruled the decision. Analyzing the state of the law at the time of the decision, the Supreme Court concluded that Pendergrass was poorly reasoned, inconsistent with relevant statutes, and “plainly out of step” with established California law at the time the decision was rendered. 

In rendering its ruling, the Supreme Court stressed that promissory fraud is not easily proven. A showing of fraudulent intent requires more than proof of nonperformance of a promise.  In other words, a contracting party cannot avoid application of the parol evidence rule simply by showing that the other party made misrepresentations or failed to keep an oral promise. 

Establishing fraud also requires a showing of justifiable reliance. This can be difficult to prove where the alleged false representation is directly at odds with the written contract or where the plaintiff admittedly never read the contract before signing. See, e.g., Rosenthal v. Great Western Fin. Sec. Corp., 14 Cal. 4th 394, 419 (1996) (party could not void contract for fraud in the execution where party never read the agreement before signing). In the insurance context, an insured’s failure to read a policy can preclude a finding a justifiable reliance as a matter of law. See Hadland v. NN Investors Life Ins. Co., 24 Cal. App. 4th 1578, 1584 (1994) (no justifiable reliance on agent’s misrepresentations that policy was “as good if not better” than existing coverage).

Conclusion

Riverisland has changed the landscape of the parol evidence rule as applied to allegations of fraud. Insurers may see this case asserted in insurance disputes involving alleged misrepresentations about the scope of coverage. Insurers no longer can argue, as a matter of course, that the parol evidence rule excludes evidence of false statements directly at odds with policy terms. Although Riverisland removed a barrier to asserting claims for fraud, this is only one hurdle that must be overcome in establishing fraud. The inability to show fraudulent intent and justifiable reliance could still prove to be fatal to many such claims.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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